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Game 1 Decide how to divide these 100kr between yourself and another randomly chosen person from this room Use amounts divisible by 10kr. Please write down how much you want to give to the other person You keep the rest for yourself You have been provisionally allocated 100kr

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Game 2 Stage 1: you (the sender) propose how to divide these 100kr between yourself and the other person Stage 2: the other person (the receiver) can accept or reject You and another randomly chosen person from this course have to split 100kr. The procedure is as follows: If the receiver rejects: you both get 0kr. If the receiver accepts: the 100kr. are shared as proposed in stage 1 Which division would you propose as sender (use multiples of 10kr.)? Suppose now you are the receiver. What is the lowest offer from the sender that you would accept?

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From homo oeconomicus to homo sapiens Prototypical economist conception of human behavior: People maximize their (discounted, expected) utility People are governed by self-interest People are fully rational, i.e., decisions result from a fully rational process of finding an optimal choice given the constraints and all information available Experimental economics: tests of economic models in the laboratory/field have shown that some basic postulates in economic theory should be modified Behavioral Economics

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What is behavioral economics Behavioral Economics increases the explanatory power of economics by providing it with more realistic psychological foundations Keep using the same powerful analytical end empirical tools but modify assumptions from standard economic theory: Examples: Realistic utility functions: social preferences, reference dependent preferences Unstable preferences: e.g. why do people make forever resolutions to go on e.g. a diet or stop smoking, only to give in later Biases, mistakes Bounded rationality

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Social preferences Why do we donate money? Why do we care about what others have? Why do we care about how others see us?

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Game 1: Dictator Game What would the standard economic model predict? What decisions do you actually expect? What motivated your decision? Decide how much of 100kr. to give to a random person

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Game 1: Dictator Game The standard economic model predicts that you keep all of the 100kr. for yourself Experimental results (e.g. Andreoni and Miller 2002): 40 percent of senders keep everything for themselves 20 percent give more than 0, but less than 50 percent to the other person 40 percent divide the amount of money equally Almost nobody gives more than 50 percent Behavior is quite sensitive to context Anonymity (also vis-a-vis experimenter) Framing: 'Wall Street Game' vs. 'Community Game'. Small changes in protocol: choice set included option to take money, moral wriggle room

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Game 2: Ultimatum Game Split of 100kr. If the receiver rejects sender’s offer, both get 0kr. If the receiver accepts: 100kr. shared as proposed What would the standard economic model predict? What decisions do you actually expect? What motivated your decision?

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Game 2: Ultimatum Game The standard economic model predicts that you propose to keep the 100kr. for yourself and that the other person accepts Numerous experimental studies from different countries, with different stake sizes and different experimental procedures, clearly refute the prediction of the standard model There are virtually no offers above 0.5 The vast majority of offers in almost any study is in the interval [0.4; 0.5] There are almost no offers below 0.2 Low offers are frequently rejected, and the probability of rejection tends to decrease with the share offered

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Public good game (social dilemma) You and 3 other people from this class form a group. Each of you can contribute to a public good You are each given 200kr. Your task is to decide how much to keep for yourself and how much to contribute to the public good Your payoff depends on how much you and the others invest in the public good / keep for themselves as follows: Your payoff= 200 - (your contribution to the PG) + 0.4 x (sum of contributions of the 4 participants)

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Predictions The standard economic model predicts that everybody contributes 0 to the public good What would be the socially efficient outcome? Compare to the prisoners’ dilemma!

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Experimental results In the lab, subjects play this game ten times in a row (with the same group members or with different group members) In the first rounds, some subjects contribute a positive amount The contribution rates are declining In the final period, the vast majority of subjects (on average 73%) play the equilibrium strategy of complete free riding (contribute nothing) So what about our social preferences now?

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A variation: PG game with punishment Suppose now that after deciding how much to contribute to the public good and learning how much each member contributed, group members can punish each other by assigning “punishment points" Punishing other participants reduces their income, but it also reduces the income of the person who punishes Standard economic theory: no punishment Let us consider the second stage (punishment stage) first (backward induction) Suppose somebody contributed 0 and you contributed 20. Should you punish him? No, because you cannot change his contribution anymore! Punishing him reduces however your own income! Thus, we should observe no punishment in the last stage But then, what should people contribute in the first stage?

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Experimental results People punish free riders: The vast majority of punishments are imposed by cooperators on the free-riders Lower contribution levels are associated with higher received punishments Consequence for cooperation: Defectors do not gain from free riding because they are being punished A strikingly large fraction of roughly 80 percent cooperates fully in the game with punishment in the final period So what about the standard theory again? How can we reconcile these puzzling facts?

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Summary In some cases the standard model works quite well and social preferences seem not to matter (market experiments, public good games) But we have also some examples where the standard model does not make the right prediction and social preferences seem to matter (dictator game, ultimatum game, public good game with punishment) Is there a simple common principle that can explain the evidence? Note: We do not want to have a model that explains one example, but not the others

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Social preferences Key idea: a player’s utility does not only depend on his own payoff, but also on the payoff of the other player Altruism (Andreoni and Miller 2000): A person is altruistic if her utility increases with the well being of other people Can explain behavior of some (but not all) people in the dictator game Can't explain behavior in ultimatum game Inequity aversion (Fehr and Schmidt 1999, Bolton and Ockenfels 2000): A person is altruistic towards other players if their material payoffs are below an equitable benchmark, but she feels envy when the other players' material payoffs exceed this level For most economic experiments it seems natural to assume that an equitable allocation is an equal monetary payoff for all players

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Summary Inequality aversion model can explain: Positive and negative actions towards other players Behavior in market, dictator, ultimatum, public and public good with punishment games (and others not mentioned) Why fairness plays a smaller role in most markets for goods (no player alone can enforce equitable outcome) than in labor markets Problems: Consider again the ultimatum game, but now suppose a computer randomly chooses for the sender Suppose the computer proposes 10kr to you (i.e., the other player would get 90kr). Would you accept or reject? What if a real person proposes 10kr to you? Inequity aversion predicts there is no difference between these two scenarios However many people would accept the offer if came from a computer but not if another person proposed it Why? Intentions matter!

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The deep bases of behavior… Our preferences are shaped by evolution our ancestors were successful at reproducing suppose that we have inherited our ancestors’ preferences (genetically, culturally) then our preferences should direct us towards maximization of reproductive success Individual selection theory suggests a world populated by resolutely selfish “homo economicus” Group selection theory: groups with internal cooperation will be more successful than other groups, and that this may cause altruistic behaviors or individual sacrifices for the common good of the group to survive and in some circumstances thrive We have ”biases” shaped by evolution Preferences can explain why some behavior is “rational” But some facets of behavior seem “hard wired” rather than a rational response

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The deep bases of behavior… Our preferences are shaped by evolution our ancestors were successful at reproducing suppose that we have inherited our ancestors’ preferences (genetically, culturally) then our preferences should direct us towards maximization of reproductive success Individual selection theory suggests a world populated by resolutely selfish “homo economicus” Group selection theory: groups with internal cooperation will be more successful than other groups, and that this may cause altruistic behaviors or individual sacrifices for the common good of the group to survive and in some circumstances thrive We have ”biases” shaped by evolution Preferences can explain why some behavior is “rational” But some facets of behavior seem “hard wired” rather than a rational response

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McGurk effect Interaction between hearing and vision in speech perception The visual information we gets from seeing a person speak changes the way we think we hear the sound Vision: very accurate Hearing: not so accurate Evolution has taught us to discriminate between low and high quality signals: If vision signal present, trust it more than auditory signal

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Are we still influenced by how we solved pre- historic decisions? Imagine you are a pre-historic caveman, who has just killed a big animal On the horizon you spot a man who sets off in your direction Should you flee or should you risk confront him in a physical fight? Models of behavior in resource conflicts suggest that adaptive strategies depend on asymmetries in fighting ability When own relative fighting ability is high (and correctly assessed), it is adaptive to escalate the conflict For humans, one key component of fighting ability is upper-body strength

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Do prehistoric traits still (unconsciously) influence our behavior? Are people able to assess physical strength from minimal cues? Pre-study: Measure strenght in one sample, show raters silhouettes Result: ratings correlate with actual strength Do they bargain differently with stronger opponents? War of attrition experiment: Part I: Participants had photos taken (all male) Part II: Randomly assigned to either control or treatment group War of attrition: two players start with 225 ECU, each second they each lose one ECU until first hits STOP button (or no money left); the one who waits longer gets a 100 ECU prize Each player gets to see silhouette of opponent (treatment group) Everyone plays between 7 and 12 rounds with new opponents

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The more different opponents are in physical strength the shorter the WoA and the more likely it is that the stronger one pockets the 100 ECU prize Findings Physical strength acts as coordination device Remarkable because strength gives no advantage per se in the game! Suggests that people apply strategies developed during evolution to modern- day problems of similar strategic form

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Conclusions Humans are deply social creatures We care about others’ wellbeing and others’ intentions Our strategies rely on (rational) consideration of our social preferences how others will respond to our behavior Our estimates of how others will respond depend partially on (hard-wired) strategies shaped by ancient evolutionary environment